Are We Witnessing A Sea Change?

I’m writing this post from 35,000 feet as I return from a terrific Opal conference in Scottsdale, AZ. The conference was focused on public pension funds. It was great to be back among industry peers and friends who I have known for years. I was impressed with the panels and the questions from the audience. However, what struck me were the several comments expressed by leading plan sponsors that identified the “securing of the promised benefits” as THEIR primary focus. They couldn’t be more right! For years, we at Ryan ALM have claimed that the primary objective in managing defined benefit plans was to SECURE benefits at both reasonable costs and with prudent risk.

However, for most of my 40-years in the pension/investment industry, achieving the return on asset (ROA) objective has been the dominant pursuit by sponsors, consultants, actuaries, etc. This objective has led to a significant migration within asset classes from a more balanced fixed income/equity mix to one that is today dominated by equity and equity-like risk products. The volatility associated with this asset mix migration has ramped up as well. Furthermore, liquidity to meet benefit payments and expenses has become more challenging.

Yet, for two days I heard several public fund sponsors tell the audience that securing benefit payments was their most important objective. I nearly jumped out of my seat on those occasions. You see, it was just roughly 5-7 years ago that I could attend an Opal conference or any other sponsor’s conference and not hear the word LIABILITY once. Now you hear the mention of pension liabilities throughout the sessions. But what really has changed? Have plan sponsors, their consultants, and actuaries really changed the focus from one that is return centric to one that has liabilities squarely in the scope? Private pension plans certainly have, but they in many cases are trying to de-risk their plans with the goal of freezing, terminating, and eventually transferring their pension liability to an insurance company.

Public pension sponsors desperately want to preserve their DB pension systems and rightly so. These plans were designed to reward their participants for a job well done. The benefits paid help participants to achieve a dignified retirement. Failure to secure the funds necessary to meet these obligations would be disastrous. Yet, the change in asset allocation witnessed during the last 2+ decades creates an environment in which huge swings in funded status can be realized leading to significant increases in contribution expenses by the sponsoring entity. These increases have gotten the attention of taxpayers, many of whom don’t have a defined benefit plan to help them retire.

Today, we have seen significant improvement in funded ratios and funded status for many public pension plans. If securing the promised benefits is truly their new focus, it is time to take some risk off the table. The prospect of rising US interest rates will lead to challenging times for total return-oriented fixed income programs. But the total return is NOT the value in fixed income. Their value is the certainty of their cash flows! Use fixed income assets currently allocated to these programs to secure the promised benefits through a cash flow matching program that will move assets in lockstep with a plan’s specific liabilities while creating the liquidity necessary to meet the monthly payments. The current fixed income allocation might just secure the next 10 years or so of benefits after contributions, which helps create a bridge of security for your risk assets that can now grow unencumbered, as they are no longer a source of liquidity.

Don’t risk your improved funding. Secure those promised benefits for the participants who have represented your system with the utmost professionalism. They deserve to be able to sleep well at night knowing that no matter what happens within the volatile segments of our capital markets that their benefits have been protected for the foreseeable future.

8 thoughts on “Are We Witnessing A Sea Change?

  1. You’ve been a big part of that change, Russ. Glad to see you’re finally starting to see evidence of your leadership!

  2. Bravo!!!

    Chris Scibelli | Managing Director
    ACR Alpine Capital Research
    T +1 310 922 9107 |E | W

    Chris Scibelli is a registered representative of IMST Distributors, LLC which is not affiliated with Alpine Investment Management or its affiliates.
    To prevent further emails, just reply and let us know.

  3. same sentiments here

  4. After benefiting from facing minor league pitching and the resulting (an unexpected) big inning in risk assets, does it make any sense to lock in gains and dollar cost average back into risk assets over the volatile next 10 years?

    • Good morning, Richard. I like the baseball references! Your suggestion is certainly one approach to taking some risk off the table at this point given the tremendous and unexpected returns (thanks, FED!). The approach that I favor is the bifurcating of assets into two buckets – beta and alpha. The beta bucket is your fixed income that will be used to match and fund the Retired Lives liability from next month as far out as the allocation permits (hopefully about 10 years). The alpha bucket is all non-bonds that will benefit from no longer providing liquidity, while also having a 10-year period to weather any storms in the markets. This strategy will keep your powder active should markets fool us once more (I don’t think so). Your suggestion of a $ weighted average approach is very sound. In any case, time to de-risk. Thanks for sharing your thoughts. Russ

    • Hey Richard – What is the probability that plans are doing anything at this time? It is so frustrating that we just ride through these market cycles without learning anything from the previous experiences!

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